Buying a new home often requires a hefty down payment and finding the cash can be tricky. To make the numbers work, some homebuyers turn to the money in their 401(k). You do have the option of borrowing against your 401(k), but you'll have to pay that money back. Your plan may allow you to make a hardship withdrawal instead, but you'll get charged a penalty for doing so. If your 401(k) is your only source of cash and you're buying your first home, your best option is to roll the 401(k) money into an individual retirement arrangement (IRA). You may still have to pay taxes, but you can use those funds to buy a home while avoiding both penalties and the need to repay the money.

Tip

Under the rules of many 401(k) plans, if you take out a 401(k) loan your contributions to the fund are stopped until the monies are paid back to the 401(K). The loan repayments are not tax deductible while the contributions were, so weigh the advantages and disadvantages, tax wise.

Using 401(K) Options

If you have money in your 401(k), you may borrow from it without paying taxes or penalties on the money. This option is only available to you if your plan allows it, and not all plans do. If yours does, you can borrow half of the vested funds in your account, up to a $50,000 limit. Note, however, that you will have to pay yourself back and you'll only have a maximum of five years to do it. Most employers deduct the loan payment from your paycheck automatically, so you'll have smaller paychecks and a monthly mortgage payment after you buy a home in this fashion. If you fail to repay your loan as agreed, you'll have to pay tax on the money.

If you don't want to pay the money back, see if your retirement plan allows hardship distributions. A hardship distribution lets you take money from your account without paying it back, but you'll have to pay taxes on it along with a 10 percent penalty if you're younger than 59 1/2 years old. Your plan will also bar you from making any contributions to your 401(k) for the next six months. Your 401(k) plan may disallow hardship distributions. It may also specify what constitutes a hardship. Some plans, for instance, allow hardship distributions only for medical bills and funeral expenses. To qualify for a hardship distribution to buy a home, you may need to prove you have extenuating circumstances. For example, you may qualify if your primary residence burned down and you have no homeowners insurance with which to replace it.

Consider an IRA Rollover

The rules for IRAs are different than those for a 401(k) and are more favorable to first time homebuyers. As a first time buyer, you can withdraw up to $10,000 from an IRA without paying any penalties on the money. If your IRA is a Roth IRA, you can make the withdrawal tax-free because you paid taxes on the money before you saved it. If you have a traditional IRA, you will have to pay taxes on the money because you didn't do so when you first put it in your IRA account. This is true whether you make a withdrawal to buy a home or upon reaching the magical age of 59 1/2.

If you have money in a 401(k) but like the homebuying benefits of an IRA, all is not lost. You may take money out of your 401(k) and roll it into a traditional IRA. To avoid any fees or penalties, ask your 401(k) plan manager to transfer the funds directly or make the check out to your IRA rather than to you personally. Once the money becomes part of your IRA, you can withdraw it to purchase a house under IRA rules rather than under the less favorable 401(k) rules.

Can Versus Should

As many science fiction films have cautioned, just because you can do something doesn't mean you should. Although you have the option of using 401(k) and IRA money to purchase a home, many financial advisers warn against doing so. One reason is time. You have only a limited number of years to save for your retirement. If you plan on hitting your retirement accounts to buy a home, make sure you have a plan to replace those funds. Yes, you can sell your home to help fund your retirement, but homes don't always appreciate. Plus, you'll pay interest on a mortgage rather than earning it in a retirement fund.

Speaking of interest, consider how much you'll lose. Let's say you have $10,000 in a 401(k) that earns 7 percent interest every year. If you leave that money where it is for 25 years, you'll have $54,000. Do the same thing with $20,000 and you'll have $108,000. Think long and hard about this before you pull your retirement money for any purchase, including a home.

About the Author

Michelle has a knack for tackling tough topics and making them simple. She uses her accounting degree and financial savvy to help readers understand real estate markets and mortgage options. She also writes about landlord and tenant laws. From appraisals to zoning, Michelle makes real estate information accessible to everyone.

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Miley, Michelle. "Can I Draw From a 401k for a Home Purchase Without Being Penalized With Taxes?" Home Guides | SF Gate, http://homeguides.sfgate.com/can-draw-401k-home-purchase-being-penalized-taxes-47776.html. 19 December 2018.

Miley, Michelle. (2018, December 19). Can I Draw From a 401k for a Home Purchase Without Being Penalized With Taxes? Home Guides | SF Gate. Retrieved from http://homeguides.sfgate.com/can-draw-401k-home-purchase-being-penalized-taxes-47776.html

Miley, Michelle. "Can I Draw From a 401k for a Home Purchase Without Being Penalized With Taxes?" last modified December 19, 2018. http://homeguides.sfgate.com/can-draw-401k-home-purchase-being-penalized-taxes-47776.html

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